Friday, November 19, 2010

"Commodity ETFs: even worse than you thought" (USO; UNG)

From FT Alphaville:

The issue of rollover and contango decay in commodity exchange traded products has received a lot of attention in the media.

Bloomberg noted, for example, how many ETF investors were caught off guard when contango hit commodity markets this year — a situation which has eaten into the value of their investments due to the premium paid to maintain a futures position indefinitely.
The writers explained the situation as follows:

When the futures contracts that commodity funds own are about to expire, fund managers have to sell them and buy new ones; otherwise they would have to take delivery of billions of dollars’ worth of raw materials. When they buy the more expensive contracts—more expensive thanks to contango—they lose money for their investors. Contango eats a fund’s seed corn, chewing away its value.

All in all, a fair and accurate explanation.
But there is one issue.

From the above, an ETF investor might presume he’ll still fair no worse than any other passive investor exposed to a futures roll in a contango market. It’s the inevitable cost of holding a futures position in a market seen rising into the future.

Wrong — the ETF investor is actually likely to fair much worse....MORE